US Auto Wreck?
Credit default swaps on carmakers trade at levels suggesting bankruptcy, but are things so bad?
July 7, 2008
GM and Ford share prices are trading at 52-week lows and investors have found that bonds from auto makers are tough to sell. At the same time, credit default swaps for both companies are at levels suggesting that they will file for bankruptcy within the next five years.
The drop in share prices comes amid a plunge in sales as well as concerns about a slowing US economy and rising oil prices that promise to continue to sap demand for products from GM, Ford and Chrysler. At the same time, fixed costs for all three firms--labor and raw materials--have risen.
"They had some bad news last week. [But] at the end of the day we don't think for a moment there is an imminent default coming there," says Matthew Meyer, managing director and head of public fixed income at AIG Investments. "Right now, we think that short of something happening we can't see--such as more problems at Rescap--we don't see a bankruptcy for GM or Ford in the near future."
Rescap, a unit of GMAC, has hurt GM because the auto giant is still co-owner of the consumer finance business. Rescap has been hobbled by a drop in mortgage lending and a jump in poorly performing loans.
Last week, Ford reported that June sales of Ford, Lincoln and Mercury vehicles dropped 28%. Jim Farley, group vice president of marketing and communications at Ford, blamed the drop in sales on rising gas prices and a weakened economy.
Shares of Ford and GM have steadily declined in recent months. Last week, Ford shares were changing hands at $4.67 each, down from a 52-week high of $9.64. GM shares traded at $10.93, down from a 52-week high of $43.20.
Ford's market cap is now at $10.45 billion, while GM's market cap is at $6.17 billion. By contrast Toyota's market cap is at $147.5 billion, while Volkswagen's market cap is at $113.53 billion.
Early in the week, credit default swaps for GM were at about 1,950 basis points. Investors buying protection for five-year corporate debt can expect to pay 32-1/2 points up front as well as a 500 basis point fee. That means buying insurance against default for $10 million of five-year GM debt will require that investors pay $3.2 million up front and 500 basis points, or $500,000, on an ongoing basis.
Ford CDS, meanwhile, are trading at 1,400 basis points and require a 29-1/2 basis point up-front payment.
Judging by these higher insurance costs, the implied default rate for Ford is at 70% over a five-year period and 80% for GM, according to a market participant who declined to be named.
"The conditions are extremely negative, particularly for US automakers," says Steve Point, portfolio manager at Glenmede Investment Management. Point does not own US automaker corporate debt. "Its been years since we owned [US] auto maker paper. It seems to be a deteriorating situation in terms of costs tied to employee medical and pension benefits. They always seem to be at a tough competitive disadvantage relative to Korean and Japanese automakers."
An auto carrier freight train at Chrysler's facility in Newark, Del.
Last week, Moody's warned in its Global Automotive Manufacturer Outlook that this year will be a tough one for car makers. Much of the demand for autos will be in developing markets such as Brazil, Russia and China, while in the US, Western Europe and Japan demand will fall through 2008. "Pressure on the sector will also result from the continued rise in fuel and commodity costs, and the ongoing expenditures to comply with government-mandated emissions requirements," Moody's warned.
In that report, Moody's had a negative outlook on Ford and GM, largely because of a drop in demand for SUVs and US trucks. Chrysler, too, is expected to suffer from the drop in demand for US trucks and SUVs, according to the credit rating agency, which has a negative outlook on Chrysler because of its reliance on truck and SUV sales as well as minimal presence outside of the US.
In its report about GM, Merrill said the spike in gas prices has rendered the large SUV segment obsolete. "The mix shift away from body-on-frame large SUVs that was generally expected over the next few years has been pulled forward to present day with the spike in gas prices and has been more extreme than expected," Merrill said.
Moody's meanwhile predicted that "the weak US economy, eroding consumer confidence, and high oil prices could result in US automotive shipments declining by more than 9% during 2008."
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